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Deposit insurance as private club - Is Germany a model?

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  • Beck, Thorsten

Abstract

The author describes, and evaluates the deposit insurance scheme set-up by private commercial banks in Germany in 1975. The scheme's funding, and management are completely private, with no pubic supervision. Where other schemes rely on monitoring by depositors to decrease moral hazard problems, the German scheme relies on peer monitoring by its member banks. The system has weathered several small bank crises, but has not yet been exposed to a major bank failure, or a systemic crisis. To what extent can it serve as a model for other countries? The success of the German scheme hasto be judged against an institutional environment that fosters contract enforcement, and the rule of law, and discourages corruption. In a country with weaker institutions, the voluntary membership might quickly lead to adverse selection, with strong banks leaving the scheme. The high coverage limit might induce bank managers, and owners to abuse the scheme. Banks might intentionally under-fund the scheme, counting on additional government resources in times of crisis. And the secrecy of funds might decrease fund managers'accountability in societies with little transparency, and much corruption. In Germany's highly concentrated commercial banking sector, the small number of banks facilitates a club atmosphere, and quick resolution of banking crises. But it could also prevent the entry of new, innovative market participants, so that the club becomes a cartel. Germany's anti-bankruptcy bias might help prevent moral hazard, but can also stifle entrepreneurship. There is a tradeoff between the efficiency gain of a privately run deposit insurance scheme, and its potentially negative impact on competition, and entrepreneurship. Although the scheme cannot easily be transplanted to developing countries, it offers lessons for other economies. Schemes with a club-like character, reinforce peer monitoring, and minimize the risk of free riding. Risk-based premiums, based on auditing by the deposit insurance scheme, create a healthy link between the protection an insurance offers, and the moral hazard it aims to prevent. One compromise might be a combination of ex-ante funding, that guarantees credibility, with depositors, and ex-post bank funding, that gives banks an incentive to monitor one another to minimize costs.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 2559.

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Date of creation: 28 Feb 2001
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Handle: RePEc:wbk:wbrwps:2559

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Keywords: Banks&Banking Reform; Financial Intermediation; Financial Crisis Management&Restructuring; Insurance&Risk Mitigation; Hazard Risk Management;

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References

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  1. Franklin Allen & Douglas Gale, 1994. "A Welfare Comparison of the German and U.S. Financial Systems," Center for Financial Institutions Working Papers 94-12, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Calomiris, Charles W., 1990. "Is Deposit Insurance Necessary? A Historical Perspective," The Journal of Economic History, Cambridge University Press, vol. 50(02), pages 283-295, June.
  3. Rafael La Porta & Florencio Lopezde-Silanes & Andrei Shleifer, 2000. "Government Ownership of Banks," NBER Working Papers 7620, National Bureau of Economic Research, Inc.
  4. Kane, Edward J., 2000. "Designing financial safety nets to fit country circumstances," Policy Research Working Paper Series 2453, The World Bank.
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  6. Kester, W. Carl, 1994. "Banks in the board room: The American versus Japanese and German experiences," Global Finance Journal, Elsevier, vol. 5(2), pages 181-204.
  7. Charles W. Calomiris, 1989. "Deposit insurance: lessons from the record," Economic Perspectives, Federal Reserve Bank of Chicago, issue May, pages 10-30.
  8. Laeven, Luc, 2000. "Banking risks around the world - the implicit safety net subsidy approach," Policy Research Working Paper Series 2473, The World Bank.
  9. Franklin Allen & Douglas Gale, . "A Welfare Comparison of the German and U.S. Financial Systems (Reprint 047)," Rodney L. White Center for Financial Research Working Papers 13-94, Wharton School Rodney L. White Center for Financial Research.
  10. G. G. Garcia, 1999. "Deposit Insurance," IMF Working Papers 99/54, International Monetary Fund.
  11. Cornes,Richard & Sandler,Todd, 1996. "The Theory of Externalities, Public Goods, and Club Goods," Cambridge Books, Cambridge University Press, number 9780521477185, October.
  12. Luc Laeven, 2002. "Bank Risk and Deposit Insurance," World Bank Economic Review, World Bank Group, vol. 16(1), pages 109-137, June.
  13. English, William B., 1993. "The decline of private deposit insurance in the United States," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 38(1), pages 57-128, June.
  14. Gorton, Gary & Schmid, Frank A., 2000. "Universal banking and the performance of German firms," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 29-80.
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Citations

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Cited by:
  1. Ralf Bebenroth & Diemo Dietrich & Uwe Vollmer, 2007. "Bank regulation and supervision in Japan and Germany: A comparison," Discussion Paper Series 211, Research Institute for Economics & Business Administration, Kobe University.
  2. Beck, T.H.L., 2004. "The incentive-compatible design of deposit insurance and bank failure resolution: Concepts and country studies," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3508405, Tilburg University.
  3. Ting-Fang Chiang & E-Ching Wu & Min-Teh Yu, 2007. "Premium setting and bank behavior in a voluntary deposit insurance scheme," Review of Quantitative Finance and Accounting, Springer, vol. 29(2), pages 205-222, August.
  4. Aidan Walsh, 2011. "Learning from pondlife and fishermen: towards a modular financial services industry," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 19(4), pages 312-322, November.
  5. Beck, T.H.L., 2008. "Resolution of failed banks by deposit insurers: Cross-country evidence," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3508404, Tilburg University.
  6. Gary Gorton & Lixin Huang, 2002. "Bank Panics and the Endogeneity of Central Banking," NBER Working Papers 9102, National Bureau of Economic Research, Inc.
  7. Goedde-Menke, Michael & Langer, Thomas & Pfingsten, Andreas, 2014. "Impact of the financial crisis on bank run risk – Danger of the days after," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 522-533.

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